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What are Economies of Scale: Examples of Internal Economies and External Economies

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An important idea in economic theory is economies of scale. If it wasn’t for the existence of this phenomena it is doubtful that the world economy would look anything like it does today.  The reason large companies and multinationals exist is because they take advantage of economy of scale.

What is Economy of Scale?

The simplest way to describe economies of scale would be to say that it refers to the fact that the more of a product you produce the cheaper each unit of this product becomes. In other words, if you are to make one million units of product x it will work out cheaper per unit then it would if you were only making 100 units. Economies of scale exist because increased production means that the fixed costs of producing the product are now spread over a larger number of units. Economies of scale can be divided into two types: internal economies and external economies.

Examples of Internal Economies

  • Bigger companies can take advantage of the most advanced technology because of their size. This technology would be beyond the reach of small companies because they are too expensive for small scale production. Bigger companies are producing units in numbers large enough to take advantage of this economy.
  • A big company is able to buy the things they need in bulk and so save money that way.
  • A big company will find it far easier to get finance on very favorable terms.
  • The big company can save money by acting as their own insurer
  • A larger company can produce more efficient management
  • Things like advertising can work out far more cost-effective for the large company.

Examples of External Economies

  • Local educational establishments may help the local population learn the skills needed to work for the company if they are a big local provider of employment. This can save the company a lot of money in needing to train staff.
  • Many local companies may grow up to support the bigger company. For example if the company uses a lot of printing material then a printers might open up in the area; this will save the company from needing to look further afield for their printing needs.
  • If a company is really big the government may do things like improve the transport links servicing their production facilities.

Diseconomies of Scale

As well as economies of scale there are also diseconomies when a company grows too big that it becomes ineffective.

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